Daito Pharmaceutical Co.,Ltd. Q2 FY2025 earnings call

Mid-Term Strategy (DTP2027) 5 Core Pillars and Progress

• Existing Business Efficiency (Primary Priority):
  • Announced the absorption merger of 100% owned subsidiary Yamato Pharmaceutical Industry, a API-focused firm based in the same Toyama region, effective June 1, 2025 under the "ONE Daito" initiative to eliminate intercompany barriers and streamline operations.
  • Launched the Portfolio Management Department (CEO-led, with 2 external expert consultants) in September 2024 to build a new stage-gate development selection framework. The first monthly portfolio meeting was held in January 2025. The framework adds ROI reviews and priority setting at each development stage to optimize resource allocation for both internal and external business development projects, and will also be applied to prioritize existing product portfolios.
• China Business Expansion:
  • Completed increasing stake in API manufacturing affiliates Senki Pharmaceutical and Dingwang Pharmaceutical from 12% to 21% in August 2024, strengthening partnership relations.
  • At 70% owned formulation manufacturing subsidiary Datong Pharmaceutical (China), one generic drug application is near approval, with a second pending. Third-party contract manufacturing business is progressing well, and the company has started preparations for capacity expansion via renovation of the existing facility's unused 3rd and 4th floors, with long-term plans for a new factory on a new site as product approvals progress.
• New Business Entry (Orphan Drugs):
  • Reached a basic agreement with Nobel Pharma for the first orphan new drug development collaboration, focused on formulation design and industrialization for a multiple system atrophy treatment. The business aligns with Daito's existing capacity: it requires small-batch, high-value production that fits into existing facility space no longer used for lower-value products, with no need for large new capital investment. Additional collaboration pipeline discussions are ongoing.
• Capital Structure and Shareholder Returns:
  • Approved a plan to repurchase and cancel 300,000 treasury shares, and implement a 2-for-1 stock split to improve share liquidity and expand the investor base, continuing the 300,000 share annual repurchase program from 2024.
• Human Capital Investment:
  • Introduced an internal open recruitment system to support talent movement and career path development. Launched monthly direct management update meetings for all managers via Microsoft Teams starting December 2024 to improve corporate transparency and alignment on strategy, with plans to expand flexible work arrangements in 2025.

Operational Updates

• The 10th formulation building, completed in December 2023 (Daito's largest ever capital investment), is still undergoing qualification and validation processes required for pharmaceutical production, so commercial launch will take additional time. Management has prioritized accelerating this process to reduce capital costs.
• R&D expenditure fell 10.7% year-over-year in the first half due to timing shifts in bioequivalence testing for generic drugs. Depreciation increased to 2.103 billion yen due to the new 10th formulation building and integrated research center startup. Capital expenditure in the first half was 1.607 billion yen, down 12.1% year-over-year, reflecting a backloaded investment schedule for the full year, with domestic capacity investment for generic drug supply now complete after the 10th formulation building.

Daito operates two core product segments: API (Active Pharmaceutical Ingredients) and Drug Products. Both segments achieved year-over-year revenue growth in the 2025 May Term Second Quarter.

• API segment: All business lines (products and commodities) grew revenue, driven by 2 newly launched products. Commodity API sales grew 14.3% year-over-year, led by increased demand for API for OTC cold and allergy drugs tied to the post-COVID easing and inbound tourism recovery. No absolute revenue split or contribution percentage was provided for the segment in the call. Total company revenue for the half-year was 24.58 billion yen, up 2.0% year-over-year.
• Drug Products segment: Overall revenue grew year-over-year, though medical contract manufacturing saw a temporary decline due to order and delivery timing delays, which management expects to recover in the full year. Similar to the API segment, OTC and general consumer drug products grew on the back of inbound tourism recovery. No absolute revenue split or contribution percentage was provided for the segment in the call.

• Management maintained the original full-year 2025 May term earnings guidance announced in July 2024, despite first half operating profit and ordinary profit progress coming in below 50% of the full-year target at 42.0%.
• Management expects offsetting factors in the second half to hit the full-year target, including: ongoing generic drug price increase negotiations with partners that are being implemented gradually; company-wide cost reduction initiatives that will begin delivering results in the second half; increased sales of high-margin products including new products launched in December 2024; increased utilization of the 10th formulation building; and growing generic drug sales volume from the accelerated shift from off-patent branded drugs to generics driven by the Japanese selected treatment system.
• The selected treatment system shift creates a negative impact on off-patent branded drug contract manufacturing (a business Daito participates in) but a positive impact on Daito's generic drug manufacturing and API businesses, and management expects the net impact to be positive as the shift progresses.

• Ongoing annual Japanese drug price revisions (started in 2021) create sustained downward pressure on profitability for domestic generic drug businesses, and the existing difficult pricing environment rules out large domestic growth for the existing business in the medium term.
• Persistent yen depreciation has driven raw material cost inflation, resulting in an estimated 120 million yen year-over-year profit decline in the first half (a sensitivity of 40 million yen per 1 JPY movement in USD/JPY).
• The increased depreciation from the large recent capital investment for the 10th formulation building and additional accounting provisions for aged inventory reduced gross profit and operating profit significantly in the first half, with inventory valuation issues cutting 213 million yen from profit.
• China market macroeconomic and geopolitical risks are generally overstated in management's view, though the market does face price competition from domestic Chinese firms, and Daito's performance will depend on partner sales capabilities after product approval.
• Daito's existing domestic generic drug business cannot deliver large double-digit growth under the current industry and regulatory environment, and new China and orphan drug businesses will require multi-year timelines to become meaningful revenue and profit contributors.
• Organisational change in the traditionally conservative Toyana-region manufacturing culture requires gradual consensus building, which slows the pace of reform.

Q: What is the baseline growth outlook for existing business, and what is the long-term potential of the company's new China and orphan drug businesses? / A: Management confirmed that the first half 2025 profit level represents the current natural baseline for existing domestic business. The annual drug price revision environment means large double-digit growth for domestic generic drug business is unlikely, so the company will focus on incremental gradual revenue and profit growth by eliminating wasteful development spending and improving operational efficiency. For China, the generic drug market is already 6-7x the size of Japan's and will grow further with population aging, and Daito's Japanese quality standards give it a competitive advantage; management expects it can become a meaningful standalone business pillar over the long term. For orphan drugs, individual products can reach tens of billions of yen in sales with high margins, no annual price cuts, and growing volume as patient awareness increases; the company aims to build this into another stable business pillar similar to its generic drug business over time. (1012 characters)

Q: How has the China business environment changed, and what key risks do you see? / A: Management does not take a pessimistic view of China risk. Pharmaceuticals are an essential product, and business operations have remained stable even in geopolitically uncertain environments in other regions the management team has experience with. Regulatory approvals and GMP inspections are now conducted fairly and predictably, aligned with ICH standards, and the market recognizes the quality advantage of Japanese pharma manufacturing. The company sees more opportunity than risk in China for its business model. (432 characters)

Q: What is the balance between dividend increases and share buybacks for shareholder returns? / A: Large domestic capital investment for generic drug capacity is now complete after the 10th formulation building, so domestic capital expenditure will decline significantly going forward. While the company will continue to invest in capacity expansion for the China business to capture long-term opportunities, it will prioritize generating free cash flow and returning capital to shareholders going forward, justifying the current share repurchase program. (387 characters)

Q: Why are you maintaining full-year guidance despite the weak first half profit performance, especially the inventory write-down impact? / A: Management is in late-stage negotiations with customers to resolve the inventory issue, and expects to achieve a resolution that will deliver a positive impact within the current fiscal year. While there is remaining uncertainty in the final outcome of these negotiations, the current base case supports keeping guidance unchanged, and management will continue to monitor the situation closely. (319 characters)